What Are Home Loans and When Do You Need to Get One?

The housing market is finally back on its feet. According to Kiplinger, there are more people looking to buy homes than at any other time since 2013.

But buying a home will most likely be the largest purchase you’ll ever make. Learning about the process of getting a home loan can protect you from major financial setbacks.

What are home loans? Check out this guide to understanding how the mortgage lending process works and how you can use it to get your first home.

What are Home Loans?

A home loan is a contract between you and a lender that allows you to buy real estate. The contract terms vary depending on the type of home loan you get.

The most common length of time borrowers have to buy real estate is 10, 15 or 30 years. Though you use the loan funds toward the purchase of the home, it technically isn’t yours until the balance is repaid in full.

Lenders have the legal right to take back the property up until your home loan balance is paid off. But most lenders work with homeowners to avoid taking back homes when payments fall behind.

If a lender is forced to take back your property, this process is called foreclosure. Both buyers and lenders try to avoid foreclosure at all costs.

When you don’t honor your home loan contract, the lender doesn’t profit as much and, in some cases, may be forced to sell the home for less than its full value.  In rare cases, lenders sell homes for less than the amount of the mortgage to recoup profits.

This happens when the market value of the home is less than the remaining amount on the mortgage loan. Selling a home for less than the mortgage amount is called a short sale.

Getting Approved

There are few things you can purchase that take longer to buy than a house. Lenders take their time going through your personal finances to make sure you can afford to repay the loan.

The loan approval process usually takes at least 30 days depending on your financial situation. Having all your documents ready for the lender to review is one way to speed up the process.

You need records of both your debt and income to help the lender determine whether the home loan you want is affordable. Here are the most common documents you’ll need when applying for a mortgage loan:

  • Copies of pay stubs showing a minimum of 30 days of income
  • Information on employers from the past two years
  • W-2s for two years
  • Two years of tax returns
  • Three months bank statements
  • If you are a business owner, year-to-date profit and loss statement plus business returns from the last two years

This is just a summary of what most lenders require. You may be asked for more documentation depending on the lender’s underwriting process.

The loan underwriter examines all your financial documents to make sure you aren’t a high risk for the bank. They analyze things like debt to income and employment to see whether you seem financially stable.

If you’re a doctor applying for a home loan, there may be special financing available to help you get qualified. Check here to learn what items you need to begin the loan approval process.

It’s not uncommon for mortgage lenders to request that borrowers not remove any money from their savings account or make any large purchases while applying for a home loan. The lender asks for checking and savings account statements throughout the underwriting process to follow up on your spending.

Paying on a Home Loan

Home loans are one of the biggest purchases most people make in a lifetime. Thirty-year mortgages are common because most people cannot afford a quick repayment on a home loan.

Mortgage loans are repaid with monthly payments that apply toward the interest and principal balance. At the beginning of the loan term, you’ll pay mostly interest on the loan.

This process is called amortization. With a home loan, amortization the amount you pay toward the principal balance of your loan increases each year.

This doesn’t mean your mortgage payments get higher. The amount of interest you pay gets lower as the principal payments get higher.

The only exception is with an interest-only loan. If you apply for an interest-only home loan, you’ll pay only interest payments for a fixed amount of time.

Once the interest-only period is up, you make larger payments toward the principal balance. The downside is that you won’t necessarily keep the same interest rate as the one you started out with.

Interest-only loans are usually adjustable rates which means the rate is subject to change every year. Conventional mortgage loans are fixed-rate which means you pay the same interest rate for the entire term of the loan.

If interest rates drop, you can reapply for a home loan to get a lower rate. This process is called refinancing.

Where Do My Payments Go?

Payments to a home loan don’t just go toward principal and interest. The amount you pay each month covers local taxes and insurances.

The taxes paid are determined based on your property value. Your local city or county government decides the percentage they will charge in property taxes each year.

If you put less than 20 percent down on your mortgage, you’ll pay private mortgage insurance (PMI). This insurance protects the lender in case you don’t repay your mortgage in full.

Do I Need a Home Loan?

You don’t need a home loan if you can afford to buy house cash. There are homes priced so low that homebuyers can afford to buy the home in cash.

These homes are often sold at a foreclosure auction or in lower-priced housing markets. What are home loans?

Home loans give you access to the funds you need to get a new condo, house or apartment. You borrow to get access to a long term place to live that can turn into an investment if it grows in value over time.

For more real estate tips and information, check our blog for updates.

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